Gold Prices in for Short-Term Rise, According to 'Gold to Oil Ratio'

Gold
appears to be headed down along with the price of crude oil.
Historically, there has been a correlation between the price of crude
oil and gold. Most gold fans and economic historians peg the ratio
between the price of gold to oil at 10:1. The price of crude oil is
currently $65.71 per barrel. Using the 10:1 ratio would mean that gold
should be priced at $657.10 per ounce. Gold is currently trading
at $590.40.

Gold has not been following the historical ratio as
geo-political pressures and concerns over terrorism have contributed to
a risk premium in the price of crude. If the historical ratio between
oil and gold is to return, either gold has to rise or crude has to
drop. I am more inclined to believe that gold will rise. Physical
demand for gold tends to be strong going into the fall.

During September, 2006 gold was priced around $590 and oil at $65. The gold to oil ratio was roughly 9:1.

Currently Gold is priced around $920 and oil at $117. The current gold to oil ratio is roughly 7.9:1.

For the historical ratio of gold to oil to remain true, either gold
would have to rise close to $1200 levels or oil would have to drop
toward $90. There are a number of factors supporting rising gold prices
in the short-term. Principally, due to the weakness in the financial
sector, the Federal Reserve must continue to lower interest rates to make access to capital easier.

The lowering of interest rates
is the medicine needed by financials to engage in income producing
activities, such as investment in alternative higher yielding currencies,
or direct investment in foreign economies. Financial institutions will
continue to borrow USD to shore up capital and in order to recover
non-performing assets.

If interest rates on the dollar approach 1% levels, the currency
will begin to gain strong favor as a carry trade currency similar to
the yen. Lower interest rates will inevitably lead to inflation
and eventually hyperinflation as we are seeing with rising oil prices.
In the short-term, gold will continue to be a strong hedge against
inflation and a falling dollar due to low interest rates.

In the medium
to long-term, I believe we will emerge with a stronger economy and a
stronger dollar. This will put downward pressure on gold. For the
moment, I expect that we are in the final bullish phase of this cycle
and will see continued and escalating daily volatility in gold prices.

I would continue to monitor shares of miners such as Yamana Gold (AUY), Gold Corp. (GG), and Barrick (ABX). I also see a large opportunity in junior miners and exploration companies such as Northgate Minerals (NXG) and US Gold (UXG). Shares of smaller gold companies have barely moved in the past
half year in light of rising gold prices. Eventually these companies
will begin to rise as capital returns to the market and overall
economic conditions improve. Earnings should improve for gold miners as
prices remain high for gold.

I would pay special attention to companies that begin to hedge their sales in the future.
For the past few years, gold miners have de-hedged their sales since
they were locked into selling gold at low prices. Now with gold prices
rising and possibly reaching over $1500 by some estimates, we should
begin to pay special attention to miners that lock in high sales prices
by selling their gold forward and hedging themselves against falling
gold prices. This will be a big opportunity going forward.

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